We routinely include arbitration provisions in agreements and I often wonder whether an arbitration is really any easier or cheaper than litigation. But what I didn’t realize before was how much latitude arbitrators have in what they can award, including, in this case, reforming the contract to grant a license far beyond what either party contemplated.

Plaintiff Timegate Studios entered into an agreement where it would develop a video game called “Section 8” and defendant Gamecock Media Group would distribute the game. The agreement was highly detailed about the parties’ relationship, including design and creation of the game, progress and expenditure milestones, marketing, and reporting and recordkeeping.

As to intellectual property rights, developer Timegate would be the “exclusive owner” of the intellectual property rights. Distributor Gamecock would have a “non-exclusive right and license … to use the Game Trademarks solely in connection with the packaging, sale, marketing, advertising and distribution” of the game and any add-ons or sequels. Gamecock was prohibited from preparing any derivative works or otherwise exploiting the Section 8 game outside of the terms of the agreement.

The game was produced but it failed expectations. Timegate sued Gamecock for breach of contract, including a claim that Gamecock misreported sales figures. Gamecock responded that Timegate failed to put forth its best efforts in developing the game and wrongfully unilaterally published a sequel and a version for a different platform. The parties, per the agreement, arbitrated the claim.

The arbitrator found that “Timegate had actively engaged in a litany of fraudulent misrepresentations and contractual breaches.” In addition to wrongfully pocketing Gamecock’s money and not spending its own, Timegate:

breached the Agreement by (1) self-publishing the Playstation 3 platform translation, or “port”, of Section 8 and (2) unilaterally developing a game sequel in direct violation of its licensing agreement with Gamecock. Timegate further breached the agreement by (3) failing to provide Gamecock with fully functioning versions of Section 8 downloadable content, (4) failing to provide a Russian translation of the game, and (5) failing to provide Gamecock with the necessary access codes corresponding to Gamecock’s exclusive right to distribute the game electronically via certain third-party websites.

The arbitrator awarded money damages of over $7 million. The arbitrator also reformed the contract, giving Gamecock a perpetual license to Timegate’s intellectual property, including the right to create sequels, ports and add-ons with no obligation to pay Timegate royalties. Gamecock moved the district court to affirm the award and Timegate objected on the basis that the arbitrator had exceeded his authority.

Where there is a finding of fraud an arbitrator may fashion an award which conflicts with contractual provisions, but the award still must be “rationally inferable from the parties’ central purpose in drafting the agreement.” The district court concluded that the perpetual license provision “takes what was a temporary licensing agreement, which required collaboration and coordination between the parties, and expands it into a permanent contract under which the parties are able to develop competing products.” It found this inconsistent with the fundamental purpose of the contract and vacated the award. Gamecock appealed.

An arbitrator’s award is sustained as long as the decision “draws its essence” from the contract, only subject to reversal if it “was so unfounded in reason and fact, so unconnected with the wording and purpose of the contract as to manifest an infidelity to the obligation of an arbitrator…. The remedy lies beyond the arbitrator’s jurisdiction only if there is no rational way to explain the remedy.”

So the question becomes simply whether granting Gamecock a perpetual license for the development of software, when it had no license even close to that in the original contract, was furthering the aims of the contract. The Court of Appeals for the Fifth Circuit found it was.

The appeals court held that the purpose of the original agreement was to create a mutually beneficial business relationship to jointly create, market and popularize a video game with each sharing in the financial success. The perpetual license indeed furthered this purpose:

As Timegate’s counsel conceded at oral argument, we are bound by the arbitrator’s factual findings regarding Timegate’s conduct—findings which identify Timegate’s pattern of deliberate fraud, deception, and willingness to violate its promises. Timegate had breached the Agreement in so many ways and its relationship with Gamecock had become so contentious that the collaborative relationship presupposed by the Agreement was no longer possible. The perpetual license granted to Gamecock represents an attempt by the arbitrator to restore to Timegate and Gamecock the fundamental goal of the Agreement: mutual access to financial benefits derived from their joint creation and distribution of Section 8.

An adequate remedy in the form of a monetary award was available for Timegate’s breaches to date; however, whether sequels or other iterations of Section 8 would or could be developed successfully and marketed profitably (particularly estimates of the amount of such profit) was so speculative that the arbitrator rationally could have concluded that a monetary award was not an appropriate remedy for those breaches. Under these circumstances, where the relationship of the parties could not be expected to be healed primarily because of the fraud of Timegate, the parties could no longer partner together to market their product jointly. The only way to give Gamecock the opportunity to benefit from the future development of variations of Section 8 was to cut Gamecock loose from Timegate and allow it to independently pursue game marketing efforts. To do this, the arbitrator granted the perpetual license to Gamecock, a remedy that also left Timegate free to develop and promote Section 8 variations on its own.

I’m good with this decision with respect to the license in the copyright to the software, but I see the possibility of trouble with an undifferentiated name. You can easily see that there now may be two very different “Section 8” games that will confuse consumers as they develop separately. I’m not a fan of disclaimers or uncontrolled use of trademarks by two parties, but here I would have at least required that the parties distinguish their versions of the game.

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Ms. Chestek is admitted to practice in Connecticut, the District of Columbia, Massachusetts, New York and North Carolina and is Board Certified by the North Carolina State Bar's Board of Legal Specialization in Trademark Law.

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